Guest Author - Guido Deboeck

In two articles posted in the last few days I wrote about short selling and warned against it if you are a relatively inexperienced investor. I recommended that short selling it is trading technique that you should know. If you are unfamiliar with it you should do some homework. I already provided a reference to an excellent book to do your homework on short selling.

William O’Neil in “How to make money selling stocks short” wrote in his introduction to the subject: “A Short sale is one in which you sell shares of a company’s stock that you don’t own. You borrow the stock certificates through your stockbroker in order to make delivery to the buyer of the shares you sold short”.

In sum, it is simply the opposite of buying first and selling later: you sell first and buy back later, hopefully at a lower price, in which case you will have a profit (less commissions).

Part I of O’Neil’s book goes on explaining the concept of short selling. Part II provides a wealth of examples that teaches you when to short sell or how to read stock charts and pick the right time for selling short. Both parts should be read and studied before you attempt any short selling!

Some of the most important points made in O’Neil’s book are:

1/ the general market should be in a downtrend and preferably relatively early on in this down trend;

2/ candidates for short sales should be relatively liquid;

3/ leaders from pervious bull cycles offer the best short sales;

4/ look for head and shoulder formations and late stage, wide, loose, improper bases that failed;

5/ often an optimal shorting point will occur after the 50 day moving average crosses below the 200 day moving average. Note on 03/05/07 the 10 day moving average of the NASDAQ crossed the 50 day moving average.

6/ finally take profits frequently.

In addition to shorting stocks there is also the possibility of shorting ETFs which is not discussed inb O'neil's book. Short selling stocks requires an up tick, meaning you cannot short a stock if the price is falling. ETFs in contrast can be shorted anytime.

The biggest volume of shorts have been applied to IWM, iShares Russell 2000 Index Fund and IWR, the iShares Russell Midcap Index fund. Other ETFs that have been used in big volume for shorts are EWG, the iShares MSCI Germany Index.

There are two ETFs you can buy (go long) that produce the effect of short selling . These are Profunds’ UltraShort QQQQ ProShares, symbol QID, and UltraShort S&P 500 ProShares, symbol SDS.

These ETFs short indexes using swaps and other derivative instruments. For example, QID attempts to produce the performance of twice the inverse of the price and yield of the Nasdaq 100 index.

Short selling remains a somewhat exotic trading technique that should only be tried by those who understand the concept, have done their homework, and for a while have done some paper trading similating short selling.

In the past week markets have been very volatile. The volatility index, a measure of the ratio of puts to calls and an indicator of "fear in the market", went all the way up to 18 (52 week high is 23) and has since dropped to 14. Nevertheless, trading in these volatile markets can produce big swings, as was evidenced again today.

03/09/07 2:30 pm. 630 words